Mathematical Theory of Interest

Test 4 sample problems - amortization

schedules and sinking funds
Andrei Ordine
October 27, 2004
Round all money values to cents (eg. $45.67), time values, percentage
rates, all other numerical answers to 2 digits after the period (eg. 1.45 years,
12.34%).
1. You are using a bank account to accumulate $1000 during 10 years. You
make deposits of 100 at the end of each year. The bank account earns interest
at the annual eective rate of 2%.
After 10 years, you withdraw $1000 from the account. What will the
balance of the account be immediately after the withdrawal?
2. You have two equivalent choices for repaying a loan of 100 over the term
of 20 years:
1. Sinking-fund method, in which the loan is serviced by 20 interest pay-
ments at the annual eective rate i and repaid by a lump-sum payment
at the end of the term. The sinking fund receives level deposits at the
end of each year and accumulates interest at the annual eective rate
of 10%.
2. Amortization by level payments at the end of each year, with the ef-
fective annual rate of interest 12%.
Find i.
3. A mortgage of $100,000 is repaid in equal installments at the end of each
month, for 25 years. Find the amount of each payment, and the amount of
1
interest in the rst payment. The nominal annual rate of interest, convertible
monthly, is 6%.
4. A mortgage of $100,000 is repaid over 20 years, at the nominal annual rate
of interest of 10%, convertible monthly. Find the total amount of interest
paid over the term of the loan in the following cases:
1. level installments at the end of each month are used,
2. level semiannual installments (at the end of each 6 months period) are
used.
5. Iggy borrows X for 10 years at an annual eective rate of 6% . If he pays
the principal and accumulated interest in one lump sum at the end of 10
years, he would pay 356.54 more in interest than if he repaid the loan with
10 level payments at the end of each year.
Calculate X .
6. Suppose you have a 25-year mortgage of $100,000 with annual payments
at the end of each year, at 8% annual eective rate of interest. Right after
your 20th payment, you wish to pay o the rest of the mortgage in one
payment.
According to the contract, however, the bank must realize a 9% yield rate
on the loan if it is repaid before the 25-year term ends.
Find the amound of the lump-sum payment.
1 Solutions
1. The balance after the withdrawal will be:
100s
10 0.02
1000 = 100
1.02
10
1
0.02
= 94.97 (1)
Answer: 94.97
2. The amount of each payment in the amortization method is
100
a
20 0.12
(2)
2
The amount of interest payment in the sinking fund method is 100 i, and
the amount of each sinking fund deposit is
100
s
20 0.1
(3)
Since the two methods are equivalent for the borrower, we have
100
a
20 0.12
= 100 i +
100
s
20 0.1
, (4)
therefore
i =
1
a
20 0.12

1
s
20 0.1
=
=
0.12
1 1.12
20

0.1
1.10
20
1
=
= 11.64%
(5)
Answer: 11.64%
3. The amount of each payment is
1
12

100, 000
a
(12)
25
=
100, 000 i
(12)
12 (1 (1 + i)
25
)
=
100, 000 0.06
12

1 +
0.06
12

12(25)
= 644.30
(6)
The interest included in the rst payment is
0.06
12
100, 000 = 500.00.
Answer: 644.30; 500.00
4. For the case of monthly repayments, the amount of each payment is
100, 000
a
(12)
20
. (7)
3
The total amount of interest paid over the term of the loan is

20
a
(12)
20
1

100, 000 =

20 0.1

1 +
0.1
12

12(20)
1

100, 000 =
= 131, 605.19
(8)
For the case of seminannual repayments, the total interest paid is

20
a
(2)
20
1

100, 000 =

20 i
(2)

1 +
0.1
12

12(20)
1

100, 000 =
= 136, 484.25
(9)
In the calculation above, the following was used:
i
(2)
= 2

1 +
0.1
12

12
1
2
1

(10)
Answer: $131,605.19, $136,484.25
5. In the case of 10 level payments, the size of each payment is
X
a
10
, (11)
therefore the total interest paid is
X

10
a
10
1

, (12)
Interest paid in the case of lump-sum repayment is
X(1.06
10
1). (13)
4
The dierence between the two payments is
X

1.06
10

10
a
10

= 356.54, (14)
therefore X = 825.00
Answer: $825.00
6. The size of each of the 20 payments is
100, 000
a
25 0.08
(15)
Let L be the amount of payment at 20 years, so that the yield rate realized
by the bank is 9%.
The present value of the cash ow of 20 repayments and the lump-sum
payment of L at 20 years is equal to 100,000:
100, 000 = a
20 0.09

100, 000
a
25 0.08
+ (1.09)
20
L, (16)
therefore
L = 100, 000

1
a
20 0.09
a
25 0.08

(1.09)
20
= 100, 000

1
(1 1.09
20
) 0.08
(1 1.08
25
) 0.09

(1.09)
20
= 81, 179.32
(17)
Answer: $81,179.32
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